TMI Blog2019 (4) TMI 412X X X X Extracts X X X X X X X X Extracts X X X X ..... h entity will be much higher as compared to the another entity where the capacity utilization is low and as such there is a higher proportion of fixed overheads which get allocated to such lower capacity/production. Thus, the right method is to identify all the fixed expenses including depreciation and to adjust the same in the ratio of the capacity utilized. We direct the TPO to exercise his powers under section 133(6) of the Act and to call for the information on capacity utilization of comparable companies. After obtaining the information, he will share the details so obtained with the assessee and give an opportunity to the assessee and grant adjustment for capacity under-utilized. Addition on account of Foreign Exchange Loss - addition u/s 43A - HELD THAT:- Any difference arising consequent to a change in the Rate of Exchange after the acquisition of such asset, the difference is adjusted against actual cost/written-down value of such asset. Thus, the condition for applicability of this section is that the capital asset is acquired from a country outside India. In the present case, the assets were purchased in India and not acquired from the country outside India. Thus, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the year out of which material worth ₹ 41,34,29,000/- was not consumed during the year and, therefore, the impact on the margin, if any, in respect of such purchases during the year is only of the material consumed and not of the material purchased and which is lying unutilized at the end of the year as closing stock. The purchase cost debited in respect of such raw material and the valuation of such material as closing stock is at same cost. Considering this fact, we direct the TPO that in case any adjustment is required to be made after giving effect to the adjustment on account of capacity and other issues decided by us in this appeal the same is to be restricted to the material purchased from the AE and consumed during the year. - ITA No. 6775/Del/2015, ITA No. 6783/Del/2015 - - - Dated:- 26-3-2019 - Shri N.K. Billaiya, Accountant Member And Shri Sudhanshu Srivastava, Judicial Member For the Assessee : Shri Ved Jain, Adv., Shri Ashish Chadha, Adv. For the Department : Shri H.K. Choudary, C.I.T. DR ORDER PER SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER : These are cross appeals arising from the final assessment order passed by the Assessing Officer ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee company with its associate/parents enterprise. 2. On the facts and in the circumstances of the case, the DRP-2 erred in directing TPO to exclude below mentioned below companies from the final set of comparables: i) Global Procurement Consultant Ltd. ii) Certification engineers International Ltd. iii) Rites Ltd., iv) REC Power Distribution Company Ltd. 3. On the facts and in the circumstances of the case, the DRP-2 erred in directing TPO/AO to ignore the figures of depreciation and machinery repairs as asset based manufacturing company like Terex India, depreciation cannot be segregated from the computation of the margins of the company which forms an integral part of the business operations of the company. 4. On the facts and in the circumstances of the case, the DRP-2 erred in deleting the addition of ₹ 2,04,92,202/- as proposed by Assessing Officer on account of foreign exchange loss. 5. The appellant craves, leave or reserving the right to amend modify, alter, add or forego any ground(s) of appeal at any time before or during the hearing of this appeal. 2.5.2 The grounds raised by the assessee in ITA No. 6783/Del/2015 are as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O, AO and DRP erred both in facts and law in not allowing adjustment to the tune of non-cenvatable customs duty on imports made by the Appellant 5.3 Adjustment for abnormal foreign exchange fluctuations The DRP ought to have considered foreign exchange loss incurred by the Appellant as abnormal and accordingly excluded the same from the operating expenses incurred by the Appellant in manufacturing segment Without prejudice to the above ground, the DRP ought to have considered 2,04,92,202 as non-operating item since the same relates to exchange fluctuations on account of purchase of fixed assets, which is a transaction in the nature of non-operating item. 6. The TPO, AO and DRP have erred, in law and facts, by disregarding the pricing policy submitted by the Appellant and the overseas benchmarking conducted to justify the arm s length nature of such transactions. Thus, DRP, and consequently TPO and AO, have erred in not appreciating the fact that the AEs have not made excessive margins on the exports made to the Appellant and accordingly, the loss was not attributable to the international transactions undertaken by the Appellant with the Aes 7. The TPO, AO and DRP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... conomic analysis in respect of BSS segment undertaken by the Appellant in accordance with the provisions of the Act read with the Rules, thereby arbitrarily rejecting the comparables chosen by the Appellant and conducting a fresh economic analysis, by selecting companies which are not comparable to the Appellant, for the determination of the ALP. Grounds common to both EDS and Manufacturing segments: 15. The TPO, AO and DRP have erred, in law and in facts, by not considering multiple year data for determining the arm s length margin/ price and restricting to only financial year (FY) 2010-11 data which was not available to the Appellant at the time of complying with the transfer pricing documentation requirements. 16. The TPO, AO and DRP have erred, in not allowing the benefit of +/- 5% under the proviso to section 92C(2) of the Income-Tax Act. 17. The AO has grossly erred in law, facts and circumstances of the case by Initiating penalty proceedings u/s. 271(1)(c) of the Act. 3.0 Since the issues involved in the cross appeals are common, both are being taken together. 3.1 Ground Nos. 1 and 5 in the Revenue s appeal are general in nature and hence need no a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orld Bank sponsored projects as can be seen from Paper Book pages 328 349. It was submitted that taking into consideration these facts, the Ld. DRP has rightly excluded this company by holding that the FAR is not similar to that of the assessee. 3.2.4 We have considered the rival submissions and have also perused the annual report of this company. On going through the same we note that this is a company promoted by the Export-Import Bank of India. Further, this company is doing mainly World Bank sponsored projects. Keeping it into consideration these facts we are of the view that this company cannot be considered to be a good comparable and the Ld. DRP was correct in directing exclusion of this comparable. Accordingly, we uphold the order of the Ld. DRP in excluding this comparable and ground 2(i) of Revenue appeal is dismissed. 3.3.0 In the assessee s appeal, Ground No. 14 is on Business Support segment regarding inclusion of 9 comparables selected by the TPO and exclusion of 4 comparables included by the assessee in its TP Study. 3.3.1 It was submitted by the Ld. AR that in case the exclusion of 1 comparable by Ld. DRP, i.e. Global Procurement Consultants Ltd. which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the Ld. DRP. 3.4.5 The assessee in its Ground Nos. 11 and 12 is challenging the directions of the Ld. DRP in not excluding the remaining comparables. 3.4.6 First we take up the Ground Nos. 2(ii), (iii) and (iv) where the Revenue is challenging the exclusion of the comparables as under: (i) Certification Engineers International Ltd.: It was submitted by the Ld. CIT DR that the services being provided by this company are technical in nature and similar to that of the assessee company. The TPO has given detailed reason in its order for inclusion of this comparable and the Ld. DRP was not justified in excluding this comparable. In reply it was submitted by the Ld. AR that this company is majorly involved in government related services and is a group concern of Engineers India Ltd., which is majorly involved in performing government related contracts. In support of his submission, the Ld. AR invited attention to the annual report of this company placed at page 294 of the Paper Book wherein the various projects undertaken by the company are listed. It was submitted by the Ld. AR that the Ld. DRP has taken into consideration all these facts and that this company has been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ld. DRP. On going through the annual report, we note that this company undertakes and manages mostly the contracts provided by Government of India. Further, the turnover of this company is more than the turnover filter adopted for the purpose of exclusion and inclusion of the comparable. The turnover of the assessee is 9.08 Crore as against 488.33 Crore of this comparable. In view of these facts, we uphold the direction of the Ld. DRP in excluding this comparable and the ground raised by the Revenue is rejected. (iii) REC Power Distribution Company Ltd.: It was submitted by the Ld. CIT DR that the TPO has selected this company as a comparable since the profile of the company is similar to that of the assessee company. It was submitted that the Ld. DRP was not justified in rejecting the same only on the ground that this company is a Government of India undertaking. In response, it was submitted by the Ld. AR that the company does not qualify the 75% service revenue filter adopted by the TPO. This fact is evident from the Profit Loss account and Schedule 6 at Paper Book Pages 273 and 277 wherein the consultancy income is shown at ₹ 6,92,57,295/-, out of the total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fits earned by this company were from the discontinued operations, i.e. the wind energy division, and the company was incurring losses in the other division. The fact that the company was majorly involved in the wind energy development is also evident from the fact that consultancy income earned by the company during the year was only ₹ 2,12,06,096/- in comparison to the income from energy charges amounting to ₹ 7,30,89,013/-. Moreover, this company follows the project completion method for accounting of its revenue from consultancy services. Taking into consideration the above facts, we are of the view that the functional profile of this company is not comparable with that of the assessee company and accordingly, we direct the AO to exclude this comparable. b) Bengal SREI Infrastructure Development Ltd.: We have perused the financial statements of the company placed at Paper Book page 433 460. On going through the same, we note that this company, during the year, was majorly involved into infrastructural development and that too for Government of India. This fact also gets supported from the Director s Report of the company and the segmental reporting of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f revenue recognition are different. Further, this company has been held to be not a good comparable by the ITAT Delhi Bench in the case of Alcatel-Lucent India Ltd. v. ITO in ITA Nos. 2154 2209/Del/2014 dated 06.04.2018 and in the case of Alcatel-Lucent India Ltd. v. DCIT in ITA No. 6856/Del/2015 dated 06.11.2017. Taking into consideration all the above facts, we are of the view that this company is not a good comparable with that of the assessee company and, accordingly, we direct the AO to exclude this comparable e) Mitcon Consultancy Engg. Services Ltd.: We have perused the financial statements of the company placed at Paper Book pages 510 564. On going through the same, we note that this company is into providing training services, and more than 25% of the income has been derived from such activities. The fact that this company is into training services is also evident from the Director s Report of the company wherein different assignments undertaken by the company are mentioned which include entrepreneurship and vocational training division, Mitcon e-school and BT and pharma centers etc. On going through the Profit and Loss A/c of this company placed at Paper Bo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ltd. v. DCIT in ITA No. 954/Ahd/2012 dated 05.06.2018, ITAT Mumbai Bench in the case of Jacobs Engineering India Pvt. Ltd. v. DCIT in ITA No. 7194/Mum/2012 dated 17.05.2017 and ITAT Pune Bench in the case of MSC Software Corporation India Pvt. Ltd. v. ACIT in ITA No. 46/PN/2013 dated 22.03.2017. Taking into consideration all the above facts, we are of the view that this company is not a good comparable with that of the assessee company and, accordingly, we direct the AO to exclude this comparable. (g) HSCC (India) Ltd.: We have perused the financial statements of the company. On going through the same, we note that this company is a Government of India Enterprise and the major part of the business is from the Government itself. Accordingly, we hold that this is not a good comparable and direct the AO to exclude the same. 3.5.0 Ground No. 3 in the Revenue s Appeal is regarding the direction of the Ld. DRP in excluding the amount of depreciation and machinery repairs while computing the margin of the assessee and the comparable in the Manufacturing segment. Ground Nos. 3 5.1 in the assessee s appeal are regarding the adjustment on account of capacity utilization ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing comparison with the comparables. It was submitted that the Ld. DRP was not justified in giving such directions as depreciation and repair of machinery are important components of the cost. 3.5.5 In response, it was submitted by the Ld. AR that while making comparison the various inequalities have to be removed while comparing the margins. It was submitted that the Ld. DRP has given detailed reasons and as such the direction given by Ld. DRP needs to be sustained. 3.5.6 In reply to Ground No. 3 of the Revenue s appeal and supporting Ground nos. 3 5.1 of the assessee s appeal, it was submitted by the Ld. AR that the assessee company has commenced its commercial operations in October, 2009 only. It was submitted that during the year under consideration, the assessee company was able to produce only 98 units of equipment, whereas the installed capacity was for 238 units. This fact is evident from the financial statements of the assessee company, wherein these details are reflected at Paper Book Page 19. It was submitted that this fact shows that the capacity utilization ratio of the assessee company is 41.17% only. It was further submitted that during the course of transfer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he comparables. It was submitted by the Ld. AR that the TPO, after appreciating this fact, however, has not given the assessee the benefit of this adjustment merely on the ground that the data of capacity utilization with regard to the comparables was not available. It was submitted that this cannot be a reason to deny capacity adjustment. The Ld. AR submitted that if something is practically difficult, it should not mean that without adjusting the differences such comparable will become a good comparable. In such a scenario, it was submitted, that no adverse inference could be drawn against the assessee. 3.5.8 It was further submitted by the Ld. AR that the TPO as well as the Ld. DRP have not controverted the fact that the capacity utilization of the assessee company was around 41.17% only. The Ld. AR emphasised that the fact that the TPO has wide powers of issuing notice u/s 133(6) of the Act and calling for requisite information, which the TPO has not exercised, shows that the TPO has not made any efforts to find out as to what was the capacity utilization level of the comparable companies. It was submitted that the matter may be remanded back to the TPO to make necessary enq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if the differences are material and reasonably accurate adjustments can be made to eliminate the material effects of such differences. In this case, neither the differences are material nor reasonably accurate adjustments can be made as the data on capacity utilization of other comparable companies is not available. Taxpayer has quoted several decisions for reliance on claim of capacity utilization adjustment. However, it is seen that in all cases, courts have enquired whether the differences are material and whether reasonably accurate adjustment can be made. As it is not possible to know whether there is material difference between capacity utilization of taxpayer and comparable companies and thereafter give reasonably accurate adjustment for the same in the present case. Hence, the claim of capacity utilization adjustment is not acceptable. 3.5.11 The TPO in his order accepts that Rule 10B(3) provides for making the adjustment if the differences are material and reasonably accurate adjustment can be made to eliminate the material effect of such differences. However, he has refused to make the adjustment, as is evident, from his order on the reasoning that neither the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... easonably accurate adjustments can be made to eliminate the material effects of such differences. 3.5.13 On going through the above Rule we note that the mandate of this rule is that an uncontrolled transaction shall be comparable if none of the differences are likely to materially affect the profit arising from such transaction and, further, reasonable accurate adjustment can be made to eliminate the material effects of such differences. Accordingly, if there is a difference which materially affects the profit and such difference can be eliminated by making reasonably accurate adjustment then only, the transaction will be comparable. It does not mean that when there is material difference and assessee or the TPO is not able to make a reasonable accurate adjustment to eliminate the effect of such difference then the transaction will become comparable. In such a situation the exercise has to be abated and TPO cannot go ahead by using the comparables without making adjustment for the differences. The TP rules are to be interpreted in a fair and equitable manner both for the tax payer and the Revenue and they cannot be used to in a way so as to be disadvantageous to the tax payer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rofit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 25. As per Section 92C of the Act, ALP is required to be computed using any of the given six methods and in the manner as is prescribed in Rule 10B of the Rules. Rule 10B in turn states that the most appropriate method would be one which inter alia provides the most reliable measure of ALP, and one of the important factors to be taken into account herein is the ability to make reliable and accurate adjustments. 26. The OECD Guidelines on this aspect is as follows:- Para 1.35 of the OECD Guidelines states as follow IT(TP)A No.2192/Bang/2017 Page 15 of 39 circumstances of the parties, and the business strategies pursued by the parties. Further, Para 2.74 of the OECD Guidelines while laying down the comparability criteria to be adopted while applying the transaction net margin method states as follows: .. Thus where the differences in the characteristics of the enterprises being compared have a material effect on the net margins being used, it would not be appropriate to apply the transactional net margi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idle capacity for the purpose of margin computation. The relevant extract is reproduced as below: 10. . We are of the considered view that underutilization of production capacity in the initial years is a vital factor which has been ignored by the authorities below while determining the ALP cost. The TPO should have made allowance for the higher overhead expenditure during the initial period of production. (ii) In the ruling of DCIT Vs Panasonic AVC Networks India Co Ltd (I.T.A. No.: 4620/De1/2011), it was held that:- 5. .. Capacity underutilization by enterprises is certainly an important factor affecting net profit margin in the open market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such IT(TP)A No.2192/Bang/2017 Page 17 of 39 an adjustment mechanism can be found, no objection can be taken to the adjustment. (iii) In the case of Biesse Manufacturing Company Limited (IT(TP) A Nos. 97 493/Bang/2015) for AY 2010-11, the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... based on information available in public domain, whereas, it may be possible to make equally reliable and accurate adjustments on the tested party (whose data would generally be easily accessible). 31. In such a scenario, one has to resort to the provisions of Rule 10B(3)(ii) which provides for making reasonably accurate adjustments for eliminating any material differences between the two transactions being compared. The purpose or intent of the comparability analysis is to examine as to whether or not, the values stated for the international transactions are at ALP i.e., whether the price charges is comparable to the price charges under an uncontrolled transaction of similar nature. The regulations don t restrict or provide that the adjustments cannot be made on the results of the tested party. Therefore, keeping in mind the aforesaid objective, the net profit margin of the tested party drawn from its financial accounts can be suitably adjusted to facilitate its comparison with other uncontrolled entities/transactions as per sub-clause (i) of rule 10B(1)(e) of the Rules itself. The absence of specific provision in Rule 10B(1)(e)(iii) of the Rules does not impede the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iate to restore this issue relating to adjustment on account of capacity utilization in the case of assessee company to the file of AO/TPO for deciding the same afresh keeping in view the said guidelines. If the exact details of capacity utilization of the comparable companies are not available in the public domain, the AO/TPO is directed to obtain the same directly from the concerned parties and to decide this issue afresh after giving assessee an opportunity of being heard. 35. Accordingly, we direct the TPO to exercise powers under section 133(6) of the Act to call for information on capacity utilization of the comparable companies such as - Installed Capacity, Actual Production in Units, Break-up of Fixed Cost and Variable Cost; Segmental/ product wise information, if any. 36. Post obtaining the information, he is requested to provide the assessee an opportunity by sharing the details so obtained, and accordingly, grant the adjustment for capacity under-utilized. Ground No.7 is decided accordingly. 3.5.14 Now, coming to the methodology to be adopted for allowing the capacity adjustment in this case. The Ld. DRP has taken cognizance of the same but inste ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... occurred on account of fluctuation in Foreign Exchange in respect of loan taken by the assessee for the purpose of capital assets and hence, the same cannot be allowed as revenue expenditure. 3.6.2 In reply, the Ld. AR submitted that the Ld. DRP was right in allowing the deduction as the issue is squarely covered by the judgement of the Hon ble Supreme Court in the case of CIT vs. Woodward Governor India Private Limited (Supra). The Ld. AR also placed reliance on the judgement of the Hon ble Delhi High Court in the case of Pr. CIT vs. Seagram Manufacturing Private Limited in ITA No. 885/2016 dated 09.12.2016 and Pr. CIT vs. Rampgreen Solutions Private Limited in ITA No. 340/2016 dated 27.05.2016. 3.6.3 We have considered the rival submissions. On going through the draft assessment order, we note that the assessee company has taken an ECB Loan from Terex Corporation for acquiring capital assets and this amount represents loss arising on account of the fluctuation in the Exchange Rate of this loan. The assessing officer disallowed the same by holding that the same was of capital nature and that in view of the provisions of section 43A of the Act the same was not revenue in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e total raw material consumed whereas the average imported raw material consumed by the comparables is only 5.93%. On this basis, it was contended by the Ld. AR that this clearly shows that the non-cenvat-able customs duty has impacted the margins earned by the assessee company during the year. It was submitted by the Ld. AR that the impact of the customs duty on the profitability of the assessee company is of an extra ordinary nature. This fact is evident from the figures of import/sales ratio for five years which were submitted before the TPO as well as before the Ld. DRP. It was contended by the Ld. AR that since the impact of the custom duty on the Profit Loss account of the assessee is of extra ordinary in nature, the same needs to be excluded while arriving at the operating margin of the assessee company. In support of its submission the Ld. AR placed on the order of ITAT Pune Bench in the case of Skoda Auto India (P.) Ltd. vs. ACIT [2009] 30 SOT 319 and on the order of ITAT Pune Bench in the case of Demag Cranes and Components India Pvt. Ltd. in ITA No. 202/PN/2007. 3.8.2 In response, the Ld. CIT DR submitted that this type of adjustment is not permissible under the TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Foreign Exchange loss. 3.9.2 The Ld. CIT DR submitted that foreign exchange loss is considered to be as normal business expenditure and cannot be excluded while computing the PLI of the assessee company. 3.9.3 We have considered the rival contentions. The issue here is exclusion of the foreign exchange loss of ₹ 2,04,92,202/- on account of restatement of loan liability. Thus, this foreign exchange loss is not on account of purchases or sales or any other revenue item. The Ld. CIT DR is correct in its contention that foreign exchange loss is considered to be normal business expenditure while computing margin of the tested party as well as the comparables. However, such foreign exchange loss is of the nature relating to revenue. In the present case, the admitted fact is that this relates to restatement of loan liability. Such expenditure, though, may be allowable as business expenditure while computing the taxable income but the fact that such expenditure is of extra-ordinary nature cannot be ignored. Therefore, we are of the view that this exchange loss of ₹ 2,04,92,202/- needs to be excluded while computing the PLI of the assessee. We are also in agreement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pon the reasoning given by Ld. DRP that the arguments raised by the assessee are not legally tenable. 3.10.3 We have considered the rival contentions. It is undisputed fact that the assessee has made purchases of ₹ 105,55,16,000/- during the year out of which material worth ₹ 41,34,29,000/- was not consumed during the year and, therefore, the impact on the margin, if any, in respect of such purchases during the year is only of the material consumed and not of the material purchased and which is lying unutilized at the end of the year as closing stock. The purchase cost debited in respect of such raw material and the valuation of such material as closing stock is at same cost. Considering this fact, we direct the TPO that in case any adjustment is required to be made after giving effect to the adjustment on account of capacity and other issues decided by us in this appeal the same is to be restricted to the material purchased from the AE and consumed during the year. 3.10.4 Ground nos. 6 and 7 stand allowed for statistical purposes. 3.11.0 Ground Nos. 8 to 10 in the assessee s appeal are general in nature and need no adjudication. 3.11.1 Ground Nos. 11 12 o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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